Today’s most common pricing structure in construction agreements is the guaranteed maximum price model—a “GMP” or “GMAX”. Under this type of Agreement, the Owner pays the Contractor its actually-incurred cost of work (as specifically limited and defined in the Agreement itself) plus a percentage for the Contractor’s profit, up to a pre-defined price. This price, as the name implies, is intended to be a guarantee to the Owner that it is the maximum amount that the Owner is required to pay1 and that any costs incurred in excess of that amount are solely the responsibility of the Contractor.
Frequently, Contractors employ several mechanisms in an effort to leave the door wide open to increases in the Contract Price, which can have the effect of rendering the agreed-to guaranteed maximum price neither guaranteed nor maximum. This is typically attempted by including several open-ended provisions in either the Construction Agreement itself or the Contractor’s “Qualifications and Assumption” exhibit to the Agreement.
So, what key provisions should a wary Owner be on the lookout for?
The first is what is known as a Price Escalation Clause. These clauses typically state that while the Contractor will attempt to buy out the Project in accordance with its initial schedule of values, should labor or material costs increase following the execution of the Agreement, the Contractor is automatically entitled to a Change Order for the full amount of such increases. While these provisions often pay lip service to the notion that the cause of the price escalation must be beyond the Contractor’s control and that the Contractor will endeavor to mitigate the effects of any such increases, the result is that the Contractor is passing 100% of the liability on to the Owner for factors that the Owner has no ability to control.
These provisions should be deleted entirely.
The second mechanism for open-ended upward adjustments to the guaranteed maximum price is the inclusion of a high number of large scope or high-dollar-value allowances within the guaranteed maximum price. An allowance is an item the Contractor cannot guarantee the price of at the time of the execution of the agreement that is identified within the guaranteed maximum price. Accordingly, it represents the Contractor’s best guess as to an item’s price, but should those prices go up over the course of the Project, the guaranteed maximum price will be increased for the full amount of each allowance item.
While a limited number of allowances have always been carried within a guaranteed maximum price agreement, these allowances were historically both minimal and specific. Recently, however, Contractors have begun both to include more allowances as well as to broaden the scope and dollar value of those allowances in order to pass 100% of the risk of such price increases to the Owner. For example, instead of listing a specific type of plumbing fixture as having an allowance of $1,000, Contractors now may include an allowance for the entire plumbing scope of work of $1,000,000.
To minimize the risks posed by allowances, the Owner should ensure that the Contractor includes only those specific materials—and never labor costs—which it cannot reasonably price at the time of the execution of the Agreement. Owners should also ensure that the sum of all allowances do not represent a significant portion of the guaranteed maximum price.
Finally, it is important to note that the list of allowances, as well as any price escalation clauses, may not be included in the terms and conditions of the Contract itself. Instead, they may be buried in the Contractor’s Clarifications and Assumptions Exhibit—sometimes also called a Qualifications Exhibit. These types of exhibits are often one of the last documents provided prior to execution, so it is of paramount importance to read them closely lest they negate any previously negotiated terms within the Contract and render a guaranteed maximum price neither guaranteed nor maximum.
Morris, Manning & Martin’s Construction Law Practice Group is experienced in representing commercial property Owners and Developers. If you need any assistance in the process of drafting and negotiating Construction, Design, or Engineering Agreements, please contact Bruce Smith, Chair of MMM’s Construction Law Practice Group, Colby Nelson, or JD Howard.
